IN THE SUPREME COURT OF THE STATE OF KANSAS
No. 89,934
IN THE MATTER OF THE APPEAL OF
THE CITY OF WICHITA FROM AN ORDER OF THE
DIVISION OF TAXATION ON AN ASSESSMENT OF SALES/USE TAX.
SYLLABUS BY THE COURT
1. The record is examined within our scope of review for the Kansas Board of Tax Appeals (BOTA) decisions, K.S.A. 77-601 et seq., and it is determined that BOTA did not err in its determination that certain interdepartmental transfers of the City of Wichita water department constitute sales of tangible personal property or services subject to taxation under K.S.A. 1992 Supp. 79-3606; that various fees charged by the water department are taxable gross receipts under K.S.A. 1992 Supp. 79-3602 and K.S.A. 1992 Supp. 79-3603; and that computer equipment purchased for another purpose but used by the water department in its operation was not exempt from compensating use tax under K.S.A. 1992 Supp. 79-3606(b).
2. Whether the doctrine of issue preclusion or claim preclusion applies in a certain situation is a question of law. An appellate court analyzes the question using an unlimited de novo standard of review.
3. Collateral estoppel applies where (1) a prior judgment has been rendered on the merits which determined the rights and liabilities of the parties on the issue based upon ultimate facts as disclosed by the pleadings and judgment, (2) the parties are the same or in privity, and (3) the issue litigated has been determined and is necessary to support the judgment. The doctrine of collateral estoppel prevents a second litigation of the same issues between the same parties or their privies even in connection with a different claim or cause of action.
4. The record is examined, and this court determines that the Kansas Department of Revenue did not make its tax assessments without a reasonable basis in both law and fact. Thus, the request from the City of Wichita for attorney fees is denied under K.S.A. 79-3268(f).
5. It is the duty of the courts to decide actual controversies by a judgment which can be carried into effect, and not to give opinions upon moot questions or abstract propositions, or to declare principles which cannot affect the matters in issue before the court.
Appeal from the Kansas Board of Tax Appeals. Opinion filed March 19, 2004. Affirmed.
Brian K. McLeod, assistant city attorney, argued the cause, and Gary Rebenstorf, city attorney, and Richard D. Greene, of Morris, Laing, Evans, Brock & Kennedy, Chartered, of Wichita, were with him on the brief for appellant.
John Michael Hale, of Legal Services Bureau, Kansas Department of Revenue, argued the cause and was on the brief for appellee.
The opinion of the court was delivered by
DAVIS, J.: The City of Wichita (City) appeals the decision of the Kansas Board of Tax Appeals (BOTA) affirming the Kansas Department of Revenue's (Revenue Department) assessment of sales tax, compensating use tax, and interest for transactions by the water utility department (water department). The City additionally appeals BOTA's denial of attorney fees and the issuance of a protective order regarding internal Revenue Department documents. We affirm.
Procedural History
The Revenue Department conducted an audit of the City for the period of June 1, 1992, through May 31, 1995, and the notice of assessment of retailer's sales tax, compensating use tax, and interest was issued on February 5, 1996. The City appealed the assessment on April 1, 1996, requesting a hearing pursuant to the Kansas Administrative Procedure Act, K.S.A. 77-501 et seq. The Secretary of Revenue's designee, Douglas Hager, conducted an administrative hearing beginning on March 27, 1997. On December 29, 1997, Secretary of Revenue Karla Pierce determined that the case should be stayed pending the resolution of the case of In re Appeal of Water District No. 1 of Johnson County, 26 Kan. App. 2d 371, 988 P.2d 267, rev. denied 268 Kan. 846 (1999), because it contained similar issues to those in this case.
On September 29, 1998, Hager wrote to the City's counsel advising of the recent amendments contained in K.S.A. 79-2975, which required that a "written final determination" should be issued on or before October 1, 1998. Hager asked the City if it wanted a final written determination issued prior to the conclusion of Johnson County. The City responded that it was requesting a final written determination on all other issues in this case, even if the primary issue would be resolved by Johnson County.
The Secretary scheduled final arguments in the case for January 14, 1999, before the issuing of a determination. On February 11, 1999, Hager bifurcated the case and issued a summary final determination upholding the assessment of sales tax on electricity purchased to pressurize water in the City's water distribution system. The parties agreed to have this sole issue decided because it related to the pending Johnson County. The appeal regarding this issue was ultimately decided by this court in In re Tax Appeal of City of Wichita, 274 Kan. 915, 59 P.3d 336 (2002) (City of Wichita I).
The remaining issues, relating to the assessment of sales tax, compensating use tax, and interest relating to the City's water department, were decided in a final written determination on June 30, 2000, by Hager's successor, David Heinemann. Heinemann upheld the Revenue Department's assessments and interest and denied the City's request for attorney fees. The City appealed this final determination to BOTA.
BOTA conducted a de novo hearing on the matter in October 2001. On June 14, 2002, BOTA entered an order affirming the assessment of sales tax on certain water department fees and interdepartmental transfers and compensating use tax on computer hardware and related equipment. BOTA denied the City's requests for an abatement of interest and for attorney fees. On November 13, 2002, BOTA issued an order on reconsideration upholding all of its original findings. The City appeals from the BOTA decision, and this court transferred the appeal from the Court of Appeals pursuant to K.S.A. 20-3018(c).
Standard of Review
BOTA is considered the paramount taxing authority in Kansas: however, if BOTA's interpretation of law is erroneous as a matter of law, appellate courts will take corrective steps. City of Wichita I, 274 Kan. at 923.
"Tax exemption statutes are to be construed in favor of imposing the tax and against allowing an exemption. However, the taxing statutes will be construed favorably to the taxpayer where there is a reasonable doubt as to the meaning of the statutes." 274 Kan. 915, Syl. ¶ 3.
K.S.A. 77-601 et seq. sets forth our scope of review. See K.S.A. 74-2426(c). K.S.A. 77-621(a) provides that "[e]xcept to the extent that this act or another statute provides otherwise: (1) The burden of proving the invalidity of agency action is on the party asserting invalidity." K.S.A. 77-621(c) further specifies that this court may grant relief in the following cases:
"(1) The agency action, or the statute or rule and regulation on which the agency action is based, is unconstitutional on its face or as applied;
"(2) the agency has acted beyond the jurisdiction conferred by any provision of law;
"(3) the agency has not decided an issue requiring resolution;
"(4) the agency has erroneously interpreted or applied the law;
"(5) the agency has engaged in an unlawful procedure or has failed to follow prescribed procedure;
"(6) the persons taking the agency action were improperly constituted as a decision-making body or subject to disqualification;
"(7) the agency action is based on a determination of fact, made or implied by the agency, that is not supported by evidence that is substantial when viewed in light of the record as a whole, which includes the agency record for judicial review, supplemented by any additional evidence received by the court under this act; or
"(8) the agency action is otherwise unreasonable, arbitrary or capricious."
Interpretation of statutes is a question of law; thus, to the extent statutory interpretation is required in this case, our review is unlimited. City of Wichita I, 274 Kan. at 924.
Interdepartmental Transfers
The City's internal auditor from 1994 to 2001, Jeanne Hernandez, testified that the various operating departments of the City, including the water department, shared services for the sake of efficiency. The data center fully costs itself, and then those charges are allocated to the user department for those services. This transaction occurs as a journal entry in the financial accounting system where it is an allocation of those expenses to the water department.
The City argues that BOTA erred in concluding that the following four categories of interdepartmental transfers were taxable:
"Interdepartmental Transfers Tax
Data Center Charges $37,692
PBX Instrument Charges $ 5,256
Long Distance Pagers $ 1,728
Photocopy Charges $ 972"
Data center charges were characterized as payments for professional services such as billing, accounting, training, personnel, and payroll and for purchases of equipment or other tangible personal property by the City.
The PBX instrument charges are the instrument charges for phones, actual phone lines, and equipment for the water department. The long distance pagers charges were allocations for pager and long distance services. The photocopy charges are accumulated by the data center's dictionary stores and its operation and allocated to the individual departments. Any equipment purchased in connection with these charges is purchased by the data center, and the cost is transferred to the water department.
Some of the expenses constitute a monthly, recurring charge, which is not recalculated each month and is simply an automated journal entry in the accounting system that transfers the expense to the water department. Some charges, like photocopying and long distance services are not automated charges and are calculated each month based on actual use. Money does not change hands, as the water department has an account number in the accounting system to which the expenses are charged. As the water department does not have its own separate bank account, the money collected from customers, i.e., the receipts from selling and furnishing of water, are deposited into the City's bank account. The expenses attributable to the water department are then noted as accounting debits and credits.
When the allocations to the water department are made, the bundle of costs for the data center charges are classified in the following categories: equipment charges, including software application fees for software such as the payroll and billing software utilized by the water department; replacement reserves for future purchases of equipment; license fees; personnel; training services; and strategic planning. When asked if the Revenue Department's audit made any effort to segregate these costs based on their taxability, Hernandez responded that the Revenue Department took out all of the labor services from the interdepartmental transfers but did not make an effort to segregate any of the other costs listed.
BOTA concluded that the interdepartmental transfers constituted taxable sales:
"62. The Board finds that the subject 'interdepartmental transfers' as they are referred to by the parties constitutes sales of tangible personal property or services. Although the consideration was recorded by journal entry, the Board finds that there was an exchange of tangible personal property for a consideration.
"63. The Board finds that implicit in K.A.R. 92-19-72 is the fundamental assumption that the initial purchase by the single legal entity is subject to sales tax or that all the various departments are independently exempt from sales tax. Administrative rules and regulations must be appropriate, reasonable, and not inconsistent with the law to be valid. Pemco, Inc. v. Kansas Department of Revenue, 258 Kan. 717, 720, 907 P.2d 863 (1995). To interpret K.A.R. 92-19-72 to allow a city to purchase property and services exempt from sales tax and then simply transfer the property to a taxable department, such as the water department, would be inconsistent and unreasonable with the law of K.S.A. 79-3606(b), and amendments thereto. As a result, the Board concludes that the subject 'interdepartmental transfers' are taxable, and the Department's assessment is sustained.
- "The Board notes that if it were to adopt the Taxpayer's assertion that the interdepartmental transfers were not 'sales,' the initial exempt purchases by the City may need to be evaluated to determine whether they were properly exempt pursuant to K.S.A. 79-3606(b), and amendments thereto. Based upon the facts presented, the property and services were used or proposed to be used in part by the political subdivision in the business of furnishing waters to others. Pursuant to K.S.A. 79-3606(b), the initial purchases by the City may not be exempt from sales tax. The Board does not believe that this is the result intended by the Taxpayer."
Discussion
The City argues that BOTA's conclusions were erroneous because the assessed transactions do not constitute "sales" as defined by K.S.A. 1992 Supp. 79-3602(c). The City contends the transactions do not involve the exchange of property for consideration; the transactions would not be considered taxable if made within any other single legal entity under K.A.R. 92-19-72; and BOTA viewed the tax imposition statue with an apparent bias in favor of taxation rather than in favor of the taxpayer, as no statute imposes tax on allocations of shared costs within a single legal entity.
K.S.A. 1992 Supp. 79-3606(b)(2) provides that the following is exempt from tax imposed by the Kansas Retailers' Sales Tax Act:
"(b) all sales of tangible personal property . . . purchased directly by the state of Kansas [or] a political subdivision thereof . . . and used exclusively for state [or] political subdivision . . . purposes, except when . . . (2) such political subdivision is engaged or proposes to engage in the business of furnishing gas, water, electricity or heat to others and such items of personal property or service are used or proposed to be used in such business."
K.S.A. 1992 Supp. 79-3602(c) defines "sales" in relevant part:
"'Sale' or 'sales' means the exchange of tangible personal property, as well as the sale thereof for money, and every transaction, conditional or otherwise, for a consideration, constituting a sale, including the sale or furnishing of electrical energy, gas, water, services or entertainment taxable under the terms of this act and including, except as provided in the following provision, the sale of the use of tangible personal property by way of a lease, license to use or the rental thereof regardless of the method by which the title, possession or right to use the tangible personal property is transferred."
The regulation corresponding to the K.S.A. 1992 Supp. 79-3606(b) exemption is found at K.A.R. 92-19-76(d):
"The exemption from sales tax for political subdivisions applies only to the extent the political subdivision is not engaged nor proposes to engage in the business of furnishing gas, water, electricity or heat to others and the tangible personal property or taxable services are used or proposed to be used in such business. When a political subdivision is engaged or proposes to engage in furnishing any of these four businesses, the political subdivision shall pay sales tax on all purchases of tangible personal property and taxable services used in these businesses. Nothing under this section of the act shall be construed to limit other exemptions which may be available to a political subdivision which furnishes gas, water, electricity or heat."
The City first argues the transaction did not involve the exchange of property for consideration because the assessments were not made on the initial purchase of property or services by the political subdivision, were not made on each use or value of use made by the water department of political subdivision property or services, and were not made on the purchase of the equipment or materials used.
The Revenue Department responds that it only taxed a percentage of the interdepartmental transfers that reasonably reflected what tangible personal property and taxable services the water department received from the City. Before figuring this percentage, the Revenue Department took the total data center charges and took out nontaxable items such as personnel and labor services in order to tax only those charges to the water department which were taxable.
Other than citing K.A.R. 92-19-72, which is discussed below, the City has provided no authority that a sale only occurs when the property or service is initially purchased, and the K.S.A. 1992 Supp. 79-3602(c) definition of sale does not include this requirement. Photocopying and long distance charges were calculated based on each use by the water department, and the remaining charges, while primarily fixed, were allocated among the departments which used them. Contrary to the City's assertion, its own internal auditor testified that the data center charges included purchases of equipment and other tangible personal property.
The water department receives this equipment, property, and services, and in exchange the expense is applied to the water department account. Each department within the City has an annual budget. Although the accounting records for the water department are not readily available, it would seemingly follow that these expenses would then be subtracted from its budget. As such, the City's argument that the transaction did not involve the exchange of property for consideration fails.
The City next argues the transactions would not be considered taxable if made within any other single legal entity under K.A.R. 92-19-72. The City argues that the taxable or nontaxable nature of the entities involved was irrelevant to the issue of whether a sale had occurred. The Revenue Department responds that the City's interpretation of K.A.R. 92-19-72, which would allow the City to buy everything tax free and transfer it to the water department tax free, would erroneously violate K.S.A. 1992 Supp. 79-3606(b).
K.A.R. 92-19-72(a), Retail Sales Between Related Entities, provides: "Each interdepartmental transfer of tangible personal property and taxable services between various departments of a single legal entity shall not constitute a sale subject to sales tax." The parties in this case have stipulated that the City, together with its various departments including the water utility, is a single legal entity.
In interpreting administrative regulations, appellate courts are to grant considerable deference to an agency's interpretation of its own regulation, which should not be disturbed unless that interpretation is clearly erroneous or inconsistent with the regulation. Murphy v. Nelson, 260 Kan. 589, 595, 921 P.2d 1225 (1996).
Administrative regulations have the force and effect of law. They are presumed to be valid, and one who attacks them has the burden of showing their invalidity. To be valid, rules or regulations of an administrative agency must be within the statutory authority conferred upon the agency and must be appropriate, reasonable, and not inconsistent with the law. Those rules or regulations that go beyond the statutory authorization violate the statute, or are inconsistent with the statutory powers of the agency have been found void. Pemco, Inc. v. Kansas Dept. of Revenue, 258 Kan. 717, 720, 907 P.2d 863 (1995).
In order to determine whether K.A.R. 92-19-72(a) is consistent with the statutory authority set forth in K.S.A. 1992 Supp. 79-3606(b)(2), it is necessary to consider the entire circumstances of the situation, including whether the entity paid tax on the initial purchase. Otherwise, as BOTA concluded, the City would be able to utilize K.A.R. 92-19-72(a) to purchase everything exempt from taxation and circumvent the specific statutory authority of K.S.A. 1992 Supp. 79-3606(b), which states that purchases for the water department are taxable. BOTA's interpretation of the regulation prevented it from being declared void.
As discussed above, the transactions between the City and its water department constituted exchanges of property for consideration, or sales. As BOTA pointed out, it is unlikely that the City would like for the initial exempt purchases (often purchases for all of the City's departments) to be evaluated as to whether they should really be exempt under K.S.A. 1992 Supp. 79-3606(b)(2), as the property and services were used in part by the political subdivision in the business of furnishing water to others. In City of Wichita I, this court found that purchases of electricity by the City which were used for both exempt and nonexempt purposes under K.S.A. 1992 Supp. 79-3606(b)(2) should not be prorated because they were used for purposes which were expressly nonexempt under law. See 274 Kan. at 933-36.
Based on this analysis, the City's final argument that BOTA viewed the imposition statute with an apparent bias in favor of taxation because no statute imposes tax on such allocations fails. K.S.A. 1992 Supp. 79-3606(b)(2) exempts from sales tax the tangible personal property purchased directly by a political subdivision and used exclusively for political subdivision purposes, except when such political subdivision is engaged or proposes to engage in the business of furnishing water. As discussed above, the "interdepartmental transfers" at issue clearly constituted an exchange of property for consideration to the taxable water department. This conclusion prevents K.A.R. 92-19-72(a) from being construed to violate K.S.A. 1992 Supp. 79-3606(b)(2) and being declared void. Giving proper deference to the agency's interpretation of this regulation, BOTA's determination that these transfers were taxable under K.S.A. 1992 Supp. 79-3606(b)(2) is upheld.
Water Department Fees
BOTA sustained the Revenue Department's assessment of six categories of water department fees as follows: (1) turn on/turn off fees--$3,315; (2) account origination fees--$11,580; (3) lawn connect fees--$372; (4) plant equity fees--$8,078; (5) fees in lieu of special assessments--$1,434; and (6) priority service charges--$733.
These fees were described by the City's director of the water and sewer departments, David Warren. The turn on/turn off fees are for the actual physical service of going to a location and physically turning on the curb stop that allows the flow of water from the City's water system through the meter and into the residence or business. This fee covers part of the cost of the personnel, the vehicle, and the equipment involved in carrying out that service. Lawn connect fees are essentially a turn on and turn off fee for a lawn meter or a lawn irrigation account.
Priority service charges were established for customers who want a turn on or turn off at a certain time. The account origination fee is a charge to a new customer for setting up a new account, and the physical aspect of originating that account occurs at city hall.
The plant equity fee is a contribution of capital from a new customer to recover part of the cost of the backbone facilities, which includes the water treatment plant, major transmission lines, and development of sources of supply. Oftentimes this fee is paid by a builder or developer in cases of new development, and the furnishing of water usually occurs after title has passed to the next builder or homeowner.
The fee in lieu of specials is also a capital recovery fee that relates to facilities such as the sewer main or water distribution line that are immediately adjacent to the property being served. If a person lives in a benefit district, the person would pay special assessments that directly pay for the facilities that are serving the property. If an owner of adjacent property that is not included in the benefit district wanted to connect to the existing line, this owner would have to make payments in lieu of special assessment to represent an equal share in the cost of that plan that has already been paid by others. Hernandez indicated that this fee could be passed on to the home buyer by being embedded in the lot price or the home price, or billed directly by the water department or the developer.
Warren testified that the turn on/turn off fees, the account origination fees, and the lawn connect fees are not included in the gross receipts from the sale of water, that water is not furnished with the payment of these fees, that the fees show up as a separate fee on the customer's bill, and that the payment of the fee does not pass title to any personal property. However, the fees are all reflected on one bill, and if the customer fails to pay the fee(s), the water department will forfeit the customer's deposit and eventually disconnect the customer's water supply.
The plant equity fee and the fee in lieu of special assessment are one time fees paid to obtain water. The plant equity fee is usually paid by a builder or developer at the time it makes an application to connect a new development to the City's infrastructure. If the developer did not pay the plant equity fees, the City would either not provide a water hookup or disconnect the water supply.
BOTA concluded that these fees were taxable gross receipts:
"53. Sales tax is imposed on the gross receipts from the sale or furnishing of water. K.S.A. 79-3603(c). In other words, sales tax is imposed on the total selling price or total cost to a consumer for the sale or furnishing of water. Ordinary words are to be given their ordinary meaning. Director of Taxation v. Kansas Crude Oil Reclaiming Co., 236 Kan. 450, 455, 691 P.2d 1303 (1984). The Board is not persuaded by the Taxpayer's argument that the occurrence of actual, simultaneous, and physical delivery of water is required for the fees to be included in the gross receipts from the sale or furnishing of water.
"54. The Kansas Court of Appeals in Newton Country Club adopted the 'mandatory-voluntary test' and found that mandatory gratuities were subject to sales tax pursuant to K.S.A. 79-3603(d) which assessed 'the gross receipts from the sale of meals or drinks.' (Emphasis added.) The mandatory gratuities were for the benefit of the employees of the taxpayer for their services rendered, not for the actual meals or drinks. The Board finds that the charges and fees at issue in this matter are similarly required to be paid in order to receive water from the Taxpayer. If a customer does not pay these fees, the Taxpayer will eventually discontinue service. In this situation, the Board finds that the consumer or account holder is required to pay these fees in order to establish or main its water service, and thus, these fees are taxable pursuant to K.S.A. 79-3603(c), and amendments thereto.
"55. Like the franchise fees in Atchison Cablevision, the subject fees should be part of the rate structure of the water department or could be separate charge. Merely by making these fees separate charges on the itemized bill, the Board finds that the Taxpayer has not removed these fees from the total cost to its consumers.
Discussion
The City argues BOTA erred in concluding that water department revenue from providing services and infrastructure was taxable pursuant to K.S.A. 1992 Supp. 79-3603(c).
K.S.A. 1992 Supp. 79-3603(c) imposes a retail sales tax on "the gross receipts from the sale or furnishing of gas, water, electricity and heat, which sale is not otherwise exempt from taxation under the provisions of this act, and whether furnished by municipally or privately owned utilities." This statute was subsequently amended to include the following additional language:
"[B]ut such tax shall not be levied and collected upon the gross receipts from: (1) The sale of a rural water district benefit unit; (2) a water system impact fee, system enhancement fee or similar fee collected by a water supplier as a condition for establishing service; or (3) connection or reconnection fees collected by a water supplier." K.S.A. 2003 Supp. 79-3603(c).
However, K.S.A. 1992 Supp. 79-3603(c) controls.
K.S.A. 1992 Supp. 79-3602(c) defines sale as "the exchange of tangible personal property . . . including the sale or furnishing of electrical energy, gas, water, services or entertainment taxable under the terms of this act." K.S.A. 1992 Supp. 79-3602(h) defines gross receipts as "the total selling price or the amount received as defined in this act, in money, credits, property or other consideration valued in money from sales at retail within this state; and embraced within the provisions of this act." "'Selling price' means the total cost to the consumer exclusive of discounts allowed and credited, but including freight and transportation charges from retailer to consumer." K.S.A. 1992 Supp. 79-3602(g).
In In re Appeal of Newton Country Club Co., 12 Kan. App. 2d 638, 753 P.2d 304 (1988), the Court of Appeals considered whether mandatory gratuities charged to customers on the sales of food and liquor in the club's restaurant and bar were subject to sales and excise tax because they were part of the club's gross receipts under K.S.A. 79-3603(d) and K.S.A. 79-41a02. The amount of the mandatory gratuity was listed separately on each ticket, the gratuities were pooled, and the club distributed the gratuities to its employees based on the number of hours they worked each week.
On appeal, the Court of Appeals adopted a mandatory-voluntary test in concluding that under the plain language of the statutes, mandatory gratuities were subject to sales and excise tax. It reasoned:
"The sales tax is imposed on the 'gross receipts,' defined as the 'selling price or the amount received . . . from sa
- "Further, the Board is not persuaded by the Taxpayer's argument that in many cases persons and entities, such as developers and builders, pay these fees, but never intend to purchase water for the location where the fees were charged. The Board does not believe that a unity of the payor of the fees to establish water service and the ultimate consumer of the water is required. The Board concludes that the Department's assessment is sustained."